Zynga Flashes $1.8 Billion Searching for the New FarmVille: Tech

Zynga Inc. employees through the "time tunnel" at the company's new headquarters in San Francisco on March 15, 2012. Photographer: David Paul Morris/Bloomberg

April 17 (Bloomberg) -- Zynga Inc. merger chief Barry
Cottle plans to step up the pace of acquisitions, spending
hundreds of millions of dollars in search of a new social-gaming
blockbuster on par with hits “FarmVille” and “CityVille.”

The biggest maker of social games paid $180 million last
month to acquire OMGPop Inc., after spending a combined $147.2
million for 22 companies in 2010 and 2011. Chief Executive
Officer Mark Pincus expects to do “a few” deals the size of
OMGPop or larger in the next three to five years, he said in an
interview at the company’s San Francisco headquarters.

In its first year as a publicly traded company, Zynga is
turning to M&A to expand into new regions and markets such as
mobile games. Led by former Electronic Arts Inc. executive
Cottle, Zynga’s retooled acquisitions team is working to speed
up its deal-making process, outbid rivals on price and do a
better job of keeping the talent it purchases. Their objective:
injecting more high-growth hits like OMGPop’s “Draw Something”
into Zynga’s portfolio of games.

“We’re sitting in a very advantageous position,” Cottle
said in an interview. “We have a significant amount of cash, we
have no debt, and we have access to debt to be as aggressive as
we need to be.”

Zynga has $1.81 billion in cash and short-term investments.
The stock fell 5.8 percent to $10.31 at the close today in New
York.

Bigger Targets

Going after more-established targets that are popular with
users and generating revenue is a shift for a company once known
for buying small and relatively unknown teams of developers,
said Nabeel Hyatt, a former entrepreneur who sold Conduit Labs
Inc. to Zynga in 2010 and is now a venture partner at Spark
Capital.

“The mandate for Barry is to go acquire not just teams,
but products that are having an impact in the market,” Hyatt
said. “That’s a whole new ballgame at Zynga. It’s a different
skill, and we will see how good Zynga is at it.”

So far, the game maker has failed to keep much of the top
talent it has acquired. Founders from at least six startups have
already left Zynga. That includes Hyatt, who left earlier this
year. Roger Dickey, who founded the popular “Mafia Wars”
franchise after Zynga acquired his startup in 2008, left the
company last year.

‘High Accountability’

“The culture of Zynga is not for everybody,” Hyatt said.
“It is a culture of very high accountability.”

A majority of the founders of acquired startups, including
those not publicly disclosed, still work with the company,
Pincus said.

Cottle, lured from Electronic Arts in January by a
compensation package worth more than $25 million, has a track
record in digital gaming. Over the past five years, he helped
Electronic Arts become a leader in mobile gaming, and, through
the company’s $400 million acquisition of Playfish Inc. in 2009,
No. 2 in social games.

Cottle’s poaching is the latest salvo in an escalating
face-off between the two game makers. Zynga has hired Electronic
Arts veterans, including its chief operating officer and
Cottle’s boss, John Schappert. EA has spent heavily marketing
social games like “The Sims,” and last year outbid Zynga to
acquire “Plants vs. Zombies” developer PopCap Games Inc. for
as much as $1.3 billion.

Facebook Reliance

Both Zynga and Electronic Arts make free games played on
Facebook Inc.’s social network. They generate revenue by selling
virtual goods within the apps -- say, a gun in “Mafia Wars” or
a tractor in “FarmVille.” Zynga, which makes more than 90
percent of its sales through Facebook, is working to decrease
that reliance by offering games on social sites, including
Google Inc.’s Google+, and on mobile devices.

Since joining Zynga, Cottle has helped refine a deal-making
process that once consisted of a handful of business-development
managers sharing a single spreadsheet of more than 400
prospective targets. Now the company brings human-resources
executives to meet acquisition candidates, asks its technical
staff to look for potential snags in technology and deploys
Pincus to convince startup founders that Zynga is entrepreneur-friendly.

“We pride ourselves on being able to move fast,” Cottle
said. “Not because we’re not thorough, but because we have a
pretty strong playbook when it comes to doing acquisitions.”

‘The Fixer’

Zynga’s thoroughness was on display last month in New York,
where OMGPop CEO Dan Porter hosted Guru Gowrappan, Zynga’s head
of M&A integration, who the company sends in to ease the
assimilation process. Nicknamed “The Fixer,” Gowrappan helped
Porter find answers to a variety of issues, from how to set up
his employees’ COBRA health benefits to getting Android-powered
handsets to use for software tests.

“He had this encyclopedic knowledge of every division in
Zynga, and just routed us,” Porter said.

After acquiring startups, Zynga says it tries to preserve
rituals that were important to individuals and teams -- for
example, maintaining a no-meeting policy on Wednesdays at Newtoy
Inc., acquired in 2010, and keeping a weekly stand-up comedy
show that the team at Conduit Labs started prior to getting
bought by Zynga.

“We bring a ton of people in to listen and understand
what’s really religious about their organization,” said Cottle.
“It’s important that the secret sauce does not change after
they become a part of Zynga.”

Offering Stock

To help persuade entrepreneurs to stay, Zynga offers stock
units that vest over two or more years. Unlike many Silicon
Valley acquirers, the company typically doesn’t structure deals
around performance incentives, or so-called earn-outs, which
reward founders with extra cash or stock after their product
gains a certain number of users, hits a revenue goal or meets
some other business objective.

“I do not like earn-outs,” said Colleen McCreary, chief
people officer at Zynga. “They encourage people to be
individual-first. Using equity that is spread out over a couple
years is a much better way” to get entrepreneurs aligned with
the rest of the company, she said.

About 17 percent of Zynga’s 2,846 employees were brought on
through acquisitions, McCreary said. That number has barely
budged in the past three years, she said.

Deal Competition

As Zynga sets its sights on bigger targets, it’s
encountering more competition. To buy OMGPop, it fended off
competing acquisition overtures from Electronic Arts, Walt
Disney Co., Gree Inc. and DeNA Co., according to a person with
knowledge of the negotiations, who asked not to be named because
the matter is private.

To close the OMGPop deal, which took just two weeks, Cottle
relied on one of his best weapons: Pincus. Zynga’s founder and
CEO met with Porter in San Francisco and convinced him that his
company supports the entrepreneurs it acquires by giving them
freedom to make the games they want.

“I felt like, if I had to own stock in all the companies
we are talking to, this is the one I would want to own stock
in,” Porter said.

Zynga’s fast action was also helped by the fact that Pincus
gained added influence over key decisions through a stock
structure that gives him 36 percent of voting power.

“We avoid a lot of steps and cycles that other public
companies have,” Pincus said. “We’re able to bring the board
along with us very quick.”

Representatives of EA, Disney, Gree and DeNA declined to
comment.

Question on Price

OMGPop was also won over by Zynga’s willingness to spend.
Though its “Draw Something” app was making about $250,000 per
day, according to the person familiar with the company, analysts
say its future revenue potential may not merit the takeover
price.

“I question the price they are paying,” said Arvind
Bhatia, an analyst at Sterne Agee & Leach Inc. in Dallas. “If
they have to every time go out and acquire the next number-one
developer for $200 million, how long can you do that?”

Zynga’s new approach to deals came about after the company
lost out on PopCap and at least three other potential
acquisitions, according to people familiar with the
negotiations. In 2010, “Rolando” creator Ngmoco LLC was bought
by Japanese firm DeNA after Zynga’s talks with the startup
failed to result in a deal. More recently, Zynga was turned away
after attempting to buy HTML5 development startup Game Closure
Inc.

‘Angry Birds’ Offer

Rovio Entertainment Oy, the Finnish maker of “Angry
Birds” games, spurned Zynga’s offer of more than $2 billion,
according to a person familiar with the company.

Representatives of EA, DeNA, Game Closure and Rovio
declined to comment.

The company’s next targets are likely to be mobile-game
makers, since it increasingly competes for the attention and
dollars of gamers who download apps from Apple Inc.’s App Store
and Google’s Android marketplace, said Michael Pachter, an
analyst at Wedbush Securities Inc. in Los Angeles.

“They are not really that competent in mobile, and they
need to be,” said Pachter, who rates shares of Zynga outperform
and doesn’t own the stock. “It’s the way that a big chunk of
the world accesses the Internet.”

Dani Dudeck, a spokeswoman for Zynga, declined to comment
on potential acquisition targets.

One major mobile developer Zynga might be eyeing is
ZeptoLab, because its hit mobile game “Cut the Rope” has
consistently landed in Apple’s rankings of top apps, Pachter
said.

Whatever companies Cottle tries to buy, he has set a
precedent for paying top dollar, Pachter said.

“You are going to have a lot of developers swinging for
the fences and trying to hit it fast and hope Zynga will give
them a couple hundred million dollars,” he said.